Most financial experts say that you should have at least three to six months of living expenses kept as a readily accessible emergency fund.
In spite of this, a recent study completed by BNZ showed that 41% of New Zealanders live from pay day to pay day, that is, basically spending their entire income before they’re paid again. People in this situation usually have limited or no savings (as they have no surplus income to save) and are putting themselves at great financial risk if the unexpected occurs, such as unemployment.
But first, what is an emergency fund:
An emergency fund is money set aside to cover the financial surprises life throws your way. Such unexpected events can be costly and stressful. An emergency fund is usually held in a readily accessible bank account, such as a savings account so that in the case of an emergency, you can access the fund quickly and without expense.
Naturally, the sum required differs between each person’s individual circumstances, as well as a reasonable estimate of what emergency costs they may be expected to meet – this means there is no “one size fits all” approach.
Even if you already have an emergency fund, read-on for the top six reasons why having one is a great idea.
1. To meet any unplanned costs
Emergency funds are part of an overall risk management plan and can nearly be considered a form of insurance – protecting you against unpleasant life events.
Having readily available funds means that you can easily navigate the inevitable storms that life throws at you. Best of all, you’ll be able to navigate these storms without getting yourself into debt or accessing funds which are invested elsewhere and may be difficult to get to and subject to variations in value.
2. Expect the unplanned to reduce your stress
“Expect problems and eat them for breakfast” – Alfred A. Montapert
It can be terribly stressful to know that you’re vulnerable to any disruption to your income, or any unforeseen expense. In practical terms, this could mean struggling to put food on the table if the car has mechanical trouble, or just knowing that something unexpected would put you further into debt.
Instead, it takes a little realism to acknowledge that through your life you will experience the ‘unexpected’, which could be in the form of events such as; a car which has broken down, unplanned travel to see a sick relative, a broken washing machine, health or dental issues, a job loss, or any other expense or event which leads to a drop in income. If you’re realistic with yourself, you will acknowledge that these unexpected things are all just a normal (even if unplanned) part of life.
When you accept such unplanned occurrences as just another part of life, and then take the practical steps to prevent them being a major disruption, it will create a sense of confidence. This confidence will enable you to sleep a little easier at night and focus on what really matters.
3. Keep you on track towards your goals
Whether you realise it or not, you’re working towards a financial goal. For many, this will be funding your retirement, for others, it will be your first home, or paying off the mortgage on your home.
If you don’t have an emergency fund then every time you run into a financial issue, you’ll have to spend some or all the funds you’re using to work towards your financial goals to meet other costs. This reduces the results of your efforts to strive towards the things that really matter (such as having a debt-free home, or a retirement nest-egg), and means you’re more likely to lose heart in the things that motivate you. Don’t let a ‘bump in the road’ divert you from reaching your financial goals.
4. Keeps you from emergency borrowing
Lenders charge a high amount of interest for short-term borrowing. Without an emergency fund, borrowing from these lenders for something such as your car breaking down means that over the course of the loan you will be paying a lot more than you initially borrowed.
This includes debt on credit cards, which can quickly accrue interest at very high rates.
5. Create good habits
Putting aside some of your income for an emergency fund is a commendable act. Taking steps which seem small at first can add up to a great overall result.
While our advisers most often recommend people keep savings and emergency funds separate from each other, the same overall principles apply to boosting both funds, or even any investment – that is, the more you set aside on a regular basis the more you’ll have.
With any investment or emergency fund, it also helps to avoid accessing it unless something that meets pre-agreed criteria has occurred. It’s best to agree on such criteria with your spouse or other family members. This sort of conversation can also be the start of forming other great financial habits, such as agreeing on how much and where to invest to achieve the things you really want in life.
6. Your emergency fund will slowly but steadily grow
Most people's emergency funds are best kept in a bank savings account. Most banks offer competitive interest rates for online accounts when you make a small deposit and no withdrawals each month. This means your contingency fund will still be able to steadily grow.
The bottom line
When you have no emergency savings, you will nearly certainly encounter unplanned issues that have a far larger impact on you than they need to. Having an easily accessible fund allows you to pay for such circumstances without interfering with your savings goals.